As a leader in the competitive video game industry, Electronic Arts (NASDAQ:EA) develops and distributes esports games. In 2013, EA stock was trading at just over $10.
Over the next few years, it became a darling among long-term investors. Then Electronic Arts stock had a rough second half of the year in 2018. And in 2019, although EA stock is up 19%, it has been a roller coaster ride.
EA stock’s 52-week price range has been between $151.26 (July 13, 2018) and $73.91 (Dec. 26, 2018). Despite the price strength this year, I don’t think long-term investors should rush to buy into the shares just yet. Electronic Arts will report earnings on May 7, giving Wall Street a better gauge of the financial health of the company. While I would not bet against EA stock’s future, I expect to see further volatility and possible price weakness in Electronic Arts stock in May. Let’s take a closer look why.
EA Stock Faces More Competition
The global gaming market has been growing at a rapid rate and is expected to exceed $180 billion in revenues in 2021. Analysts believe esports will become a major disruptive force, with a market that will exceed $1 billion this year and with a revenue increase of 26.7% year-over-year. Most of the revenues for the companies in this segment currently come from North America and China.
Such a growth industry inevitably attracts global competition. For example, Fortnite, an apocalyptic survival video game developed and marketed by the privately held Epic Games, generated $2.4 billion in sales last year, more than any single game in 2018. This free-to-play game has become a worldwide champion among gamers of all ages. Free-to-play games allow casual gamers to get a taste of the industry, especially among low-income players both in developed economies and emerging markets, such as China and Russia.
Electronic Arts is currently franchise-reliant, whereas competition like Fortnite tends to focus on video game volume. EA’s top franchise titles include FIFA Online, SimCity, The Sims and Battlefield. Each of these titles generates stable yet not-necessarily impressive sales. In other words, if EA’s core franchises were to lose popularity, the company would face fiscal and market consequences and the EA share price would suffer.
And that’s exactly what happened following its most recent earnings release on Feb. 5 when Electronic Arts disappointed the Street with lower-than-expected sales for Battlefield V. The group blamed the game’s late launch date as well as the fact that the title also lacked a multiplayer battle royale mode.
Investors were not thrilled to hear about shortfall or the blame game. As a result, EA stock plunged by 13%. The numbers confirmed that Fortnite took users from other games, including EA’s historical franchises.
But then on Feb. 8, Electronic Arts stock surged more than 9% when the company announced the surprise release of a new free-to-play, battle royale game, Apex Legends, which investors now hope may ultimately rival Fortnite. As of mid-March, about 50 million players had already dived into Apex.
However, Wall Street still has question marks as to whether Electronic Arts can maintain sustained growth since Apex Legends is entering an already-saturated and competitive market. Will EA be able to make any sizable profit from this game by monetizing the premium in-game content?
Electronic Arts Stock and Earnings Season Worries
EA is one of the largest gaming companies globally in terms of revenue and market cap. The group has two key sources of revenues:
- Products (i.e., digital or physical sale of games and additional content); and,
- Services (i.e., recurring revenue sources such as subscription-based models and in-game transactions).
In-game transactions which include “microtransactions” (such as new player skins or weapons) and “loot boxes” (whose contents players do not know prior to purchase) are lucrative yet somewhat controversial sources of revenue. Indeed, many gamers resent the idea of spending more money on games which they have already bought.
The gaming giant reports sales by platforms:
- PC and other (about 15% of sales);
- Console (about 70% of sales); and,
- Mobile (about 15% of sales).
Apex Legends is only available to play on console and PC right now. However, Fortnite supports cross-platform play, including mobile devices. Therefore, unless Apex Legends becomes available on mobile to, its momentum and growth might be limited.
In its February earnings report, Electronic Arts highlighted challenges for 2019 and decreased its revenue outlook for the year to $4.875 billion from a prior $5.15 billion. Similarly, the stock price of Activision Blizzard (NASDAQ:ATVI), one of EA’s main competitors, has also suffered so far in 2019, mostly due to the competitive headwinds in the industry.
In other words, Electronic Arts stock holders as well as investors in other entertainment and gaming stocks are nervous about each of these companies not being able to dispel fears of Fortnite and other competition. In an industry that offers both free-to-play titles and full-price games, what will be the right mix of business models for Electronic Arts?
Most investors are likely to wait on the sidelines until they have a chance to analyze EA’s balance sheet to see if the shares might be somewhat overvalued. They will also want to see if there is any growth fatigue or major trend changes in the industry.
Unless the numbers and the rest of the 2019 guidance are exceptional in May, EA stock investors may decide not to invest in the stock for several more weeks — or even months.
Should Investors Buy EA Stock Ahead of Earnings?
Electronic Arts stock is momentum-driven, hence it usually experiences big price swings after reporting earnings. In other words, it can easily gap up if the numbers are better than expected, or if the numbers disappoint, the stock can easily gap down, too.
The stock’s beta is 1.14, which means its volatility on average is 14% higher than that of the broader market. Therefore, if the industry or the overall market declines as other companies release earnings, the EA stock price may also be adversely affected.
If you already own EA stock, you might want to hold your position. However, within the parameters of your portfolio allocation and risk/return profile, you may consider placing a stop loss at about 3%-5% below the current price point.
After the upcoming earnings call, in case of a price drop, if you still believe in the bull case for Electronic Arts stock, then you might consider waiting for a better time to buy, such as when the share price is around the high $80’s, or even lower.
If you are an experienced investor in the options market, you may also consider using a covered call strategy with approximately a five-week time horizon. In that case, you may, for example, buy 100 shares of EA at a limit price of $94.47 (the closing price on April 26) and, at the same time, sell a EA May 31 $94.5 call option, which currently trades at $5.05 and offers downside protection in case of volatility and a decline in Electronic Arts stock. This call option would stop trading on May 31, 2019, and expire on June 1.
The Bottom Line on Electronic Arts Stock
Game publishing is a risky and evolving business. With its strong franchise focus, EA is an important company that is likely to weather the ebbs and flows of the industry. The rise of the digital gaming revolution is here to stay, and I believe the long-term fundamental story of Electronic Arts stock is still intact. However, I would not advocate bottom-picking in case of near-term price weakness during a subdued earnings season in May.
Investors who are interested in companies in the interactive software, entertainment or communication services but do not want to commit all their capital to a single stock such as EA may also consider investing in various exchange-traded funds (ETFs) that have Electronic Arts as a holding. Examples of such funds would include the the VanEck Vectors Video Gaming and eSports ETF (NYSEARCA:ESPO), which has EA stock as 5.74% of its 26-stock holdings. Electronic Arts stock is also among the top 20 holdings in the Invesco Dynamic Software ETF (NYSEARCA:PSJ) and the iShares Expanded Tech-Software Sector ETF(CBOE:IGV).
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.
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